Procurement Leaders Should Let Up on Cost Reduction Already
For most business leaders, it's difficult to make any decision without letting bottom line bias come into play. Globalization, in addition to evolving social, economic and regulatory trends, has elevated corporate competition to a new playing field altogether. For procurement departments in particular, cutting costs, doing more with less, and running agile operations are the new standards for success.
According to a 2014 Deloitte survey, 69 percent of chief procurement officers view cost reduction as a key business strategy. At first blush, this seems like an honorable challenge: to maintain a more efficient procurement function and reduce excess. But having cost-reduction tunnel vision comes with risks and can threaten supplier relationships in the long run. Spats over quality, service and deliveries are just a sampling of the issues that stem from a singular cost-cutting procurement mentality. Letting narrowly defined financials drive every decision is an unsustainable approach; constantly squeezing suppliers in hopes of getting a better deal can create damaging tension and mistrust.
Truly successful procurement departments balance their own needs with suppliers', and understand that costs are just one variable to consider when evaluating performance.
The risks of defining relationships with dollar signs
Mindful spending and nurturing relationships are critical components of running a strong procurement team. When an organization's motivation to slash expenses gets wrapped up in supplier relationships, procurement lands itself in a precarious spot.
Letting the need for cost reduction dictate communication with potential or current suppliers only hurts the chance of creating a fruitful relationship in the future—and can backfire on businesses. By habitually demanding lower prices, procurement departments could see a noticeable decline in product and service quality (getting deliveries straight from the "clearance" bin). In the near term, overtly cost-conscious behavior may lead to production shortages or disruptions, as suppliers prioritize deliveries and responsiveness to more profitable customers.
Looking further out, asking to spend less could place undue strain on suppliers' success. Eager-to-please suppliers may acquiesce to renegotiations without realizing the effect on their own profits. Down the road, this could stunt their ability to innovate, grow or maintain basic service levels.
Formulating a better approach to supplier evaluations
According to 2012 research from Bain & Company, most organizations lack a predefined, systematic road map for minimizing procurement costs. Developing a more formal process for evaluating supplier performance is an essential first step to smarter spending. Ideally, this would be a shared process between procurement managers and suppliers, to ensure transparency and a more open dialogue.
An effective approach to procurement and supplier management involves a diverse mix of metrics and automation, as well as data sources from within and outside of an organization.
At a minimum, procurement teams needed access to a handful of telling supplier metrics, such as supplier compliance, service quality, adherence to deadlines and frequency of supply shortages. Most organizations already house this information somewhere in their ERP, contract or invoice management systems. Equally important to collect are details that illustrate a supplier's risk potential; this could be qualitative or quantitative information, including financials, credit standing and sustainability practices. Organizations also need a way to centralize and standardize supplier observations from any internal stakeholders. Taking note of factors like suppliers' responsiveness and industry expertise, security protocols, and their ability to innovate helps paint a clearer picture for procurement teams.
In the spirit of cost reduction, organizations can benefit from building or implementing sophisticated databases of supplier pricing information. Procurement managers should be able to dig deep into this information and compare prices broken down according to specific cost components (e.g., labor, R&D, raw materials, etc.). The more granular the data, the easier it becomes to identify where a supplier's real value is. This kind of rich information helps procurement teams better understand their suppliers' operations, allowing them to shift the conversation from "How can we get better prices?" to "How can we help each other?"
There are a slate of advantages to adopting this kind of comprehensive process. For one, a robust data repository gives procurement staff the ability to uniformly compare a large volume of suppliers across different sectors and geographies. Individual supplier assessments can be aggregated and analyzed in order to create a baseline grading system. Above all else, it empowers procurement staff to act as real partners to their suppliers, not just callous price negotiators—and, as a result, realize sustainable savings.
Turning the spotlight inward
Beyond pursuing better supplier evaluations, procurement departments can maximize resources with more thorough internal benchmarking. If organizations hold their suppliers to a standard of continuous improvement, the same expectation should apply to the procurement team. More often that not, organizations under-manage procurement. Even worse, firms fail to realize that they already have the requisite data to gauge internal performance.
Spend under management, for example, is one of the most revealing metrics for determining if procurement budgets are being used efficiently. Procurement officers need to understand their current spend under management before pushing suppliers for better costs (and risking relationships). By looking at the number of active contracts in place, how closely the procurement team sticks to its sourcing schedule, and the documentation of expenditures on requisition orders (across all procurement categories), business leaders may uncover new in-house cost savings opportunities.
Keeping tabs on an organization's supplier count per category and contract compliance are other quick, non-invasive ways to assess procurement's performance. Contracting with too many suppliers in any given category could indicate potential to reduce costs, or help managers identify which suppliers to negotiate new terms with. Contracting with too few suppliers may introduce unwanted risk into an organization, increasing the likelihood of unforeseen expenses later on.
Similarly, contract compliance speaks volumes about how well procurement funds are allocated. Procurement officers must know what portion of their team's contracted spend is being used, and if category managers are making unauthorized off-contract purchases. Such rogue behavior could jeopardize a firm's reputation among suppliers, straining future attempts at price negotiations.
Focus on the right numbers
Cost cutting is a straightforward solution to maintaining a healthy bottom line, but for procurement departments, it can't be the only approach. The risks of turning off current suppliers and sacrificing service levels outweigh any short-term savings, and may even inflate expenses in the future.
Rather than set blanket cost-reduction targets, procurement leaders should enforce data-driven processes that keep both suppliers and procurement staff accountable for results. Dollar signs only reveal so much when evaluating procurement operations. With a diverse set of metrics at their disposal, organizations can diagnose hidden risks and detect sustainable savings opportunities—without harming their most valuable relationships.